G-2008-31

Horizontal cooperation among franchisees is now a well-known reality in franchising, as exemplified by the growing number of franchisee associations and advertising cooperatives. However, there is little understanding of the circumstances that favor cooperation among franchisees, of the effects of that cooperation on franchisor profits, and of the relationships between franchise partners. An analytical model featuring a franchisor and two adjacent franchisees is proposed, to investigate the impact of horizontal externalities such as price competition and advertising spillover on franchisees' decision to cooperate. Our main findings are the following: The franchisees' decision to cooperate or not depends on the type of franchise contracts and the externalities that come with it. Cooperation among franchisees is not an issue for either the franchisees or franchisor when franchise contracts can guarantee a local monopoly to each franchisee. Contracts that allow price competition and well-targeted local advertising offer good grounds for horizontal cooperation, which may or may not benefit the franchisor, depending on whether the prices within the franchise are strategic substitutes or strategic complements. Contracts in which price competition is allowed and in which the burden of advertising decisions is totally transferred to the franchisor lead to cooperation between franchisees at the expense of the franchisor. Under franchise contracts where price competition does not exist, but where franchisees are given the responsibility to undertake local advertising, franchisees do not cooperate if local advertising is predatory and the franchisor welcomes this decision. Also, the franchisor endorses cooperation between franchisees when local advertising has a public-good nature, but such cooperation can never occur when the impact of local advertising on demand is predominant.